The true cost of borrowing

Tough new rules are set to force lenders to reveal the hidden charges they make when you borrow money. The rules will cover both mortgages and personal loans.

All loans currently quote an annual percentage rate (APR) which is supposed to show the true cost of borrowing.

But it has become apparent that APRs are seriously flawed. Lenders could calculate them in various ways which could confuse and mislead borrowers.

Under the new Department of Trade and Industry regulations, the cost of all compulsory payment protection insurance associated with loans must be included when the lender quotes the APR.

There will also be changes to the way APRs on low start and discount mortgages are quoted, to ensure they reflect the true cost of borrowing over the whole term of the mortgage.

The Office of Fair Trading says the improved rules, which come into effect on Friday, will also prevent lenders disguising the true cost of borrowing by bundling expensive insurance with cheap personal loans. They will cover loans sold with payment protection insurance which includes life insurance.

Often adverts promote a low interest rate but do not make it clear that the rate is available only if the borrower buys expensive payment protection insurance.

Adverts have shown a lower interest rate where insurance is taken and a higher rate when it is not. But if the insurance had been properly reflected in the total cost of credit, the APR would be much higher. Davinder Shergill, Abbey National's personal loans manager, says: 'This practice did the customer no favours and hardly covered the industry in glory. Those lenders will now have to look to their laurels and provide fair and transparent headline rates.'

John Bridgeman, the Director General of Fair Trading, says: 'Lenders want to advertise competitive rates, but too often the headline figure is being used to hook new borrowers rather than describe what is on offer.

'Borrowers must be given sufficient information to enable them to compare products.

'Some lenders are trying to hide the cost of payment protection insurance by linking it to a discounted interest rate.

'While insurance may be useful, it is being aggressively promoted and I am concerned that borrowers are being tempted into taking something that may not suit their circumstances and without

knowing how much it will cost them in the long term.'

The main changes affecting mortgages will cover discounts and low fixed rates.

The APR on a low start mortgage must also now reflect the likely total cost over its entire life - not just the introductory period.

All lenders must also now use the same formula for calculating an APR.

From now on, the APR must include all of the following: interest charges, brokerage fees, payment protection insurance, most other insurance charges, arrangement fees, booking fees and sometimes survey fees.